This course is designed to serve as a transition between the method-oriented courses in the early phase of the QFin-program to the core finance courses that will follow. In this sense, the goal of the course is to introduce students to some of the main concepts in finance in order to prepare them for the specialized courses in the second year, such as asset pricing and corporate finance. En route to this goal, we build on the skills and tools that students have acquired in preceding QFin-courses, in particular microeconomics, mathematics, and statistics.

The main reference text for this course is Jarrow (1988), and I suggest that students read most of the book, i.e. chapters 2 to 16. Whenever the book goes into much technical detail, this course prioritizes economic intuition. The motivation for this approach is that students have already heard details on some concepts in earlier courses (e.g. on utility theory in microeconomics) and will revisit others in much more depth in the second year (mostly in asset pricing).

Jarrow's book is structured in two parts; in the first he studies models under certainty (chapters 2 to 6), in the second, he studies models with uncertainty, based arbitrage pricing theory (chapters 7 to 13) and based on equilibrium models (chapters 14 to 19). The course deviates from the certainty vs. uncertainty structure and instead organizes its sections by topics:   

• Preferences, financial decisions, and prices. This section shows how we can derive asset prices in simple equilibrium models under certainty as well as under uncertainty. The corresponding chapters in the book, also containing material covered in microeconomics (i.e.,  preferences and utility theory), are chapters 2, 3, 5, 6, 7, and 14. 

• Capital Asset Pricing Model (CAPM). In the second section, we derive the CAPM (i) as a special case of the general pricing formula derived in the first section and (ii) from mean-variance preferences using portfolio theory. Much of this and more details are covered in chapters 15 and 16. Additionally, we discuss empirical evidence on the validity and failure of the CAPM.    

• Arbitrage Pricing Theory (APT). With arbitrage pricing theory, we sacrifice some of the economic appeal provided by equilibrium models for the benefit of weaker assumptions and flexibility of empirical models inspired by APT. The conceptual discussion follows chapters 8 and 9 very closely. Additionally, we discuss some prominent factor models that appear to work quite well empirically, e.g. those proposed by Fama and French.

• Multiperiod economies: Interest rates and derivatives. In this section, we extend arbitrage pricing to a multiperiod setup. In this setup, we discuss the pricing of default-free bonds using no-arbitrage buy-and-hold strategies and derivatives using no-arbitrage dynamic strategies. The discussion follows chapters 12 and 13 and will be complemented by material on recent developments around derivatives and practical applications.

• Corporate finance. In the last section, we use arbitrage pricing theory to study some basic questions in corporate finance. Our discussion focuses on how the value of a firm is affected by the firm's choice of equity vs debt capital and by its dividend policy, following chapters 4, 10, and 11.

After completing this course students will have the ability to:

• Understand the principles of decision making under certainty and uncertainty. 

• Understand the basics of and differences between equilibrium pricing and arbitrage pricing.

• Understand the role of diversification and optimal portfolio choice for asset pricing. 

• Analyze basic corporate financial decisions.

Full attendance is compulsory. This means that students should attend at least 80% of all lectures, at most one lecture can be missed.

Lectures with exercises and applications.

Two home assignments (each 30% of the grade) and a final exam (40% of the grade). Details will be announced in due course.

Students in the MAQFIN-14 curriculum who have not obtained a positive grade for Principles of Finance, can re-register for this respective course and attend it once again.

christian.wagner@wu.ac.at

see course outline